Winter Update

From April to June 2017 diversified portfolios again delivered generally positive returns, although at a more subdued rate than investors have become accustomed to in recent quarters.

For much of the second quarter major markets were relatively benign, perhaps distracted by the prolonged attention given to two very important elections in Europe.

The first was the victory by 39 year old Emmanuel Macron’s upstart En Marche! political party in France.

This result was the latest in a recent string of good news for Europe.

Already, Macron is shaping up as just the tonic Europe needs. A fierce critic of Brexit, he wants to ensure that the UK gets no special treatment during its upcoming divorce proceedings.

He also champions Greek debt relief, an issue which has plagued the euro zone for years because of Germany’s fierce opposition to it. If Macron can help Germany and Greece inch forward on this issue, it would do wonders for EU morale.

Economically speaking, Europe is already in much better shape than it was a few years ago. Every country in the EU is now growing (even Greece…just). Data for the first quarter of 2017 showed the euro zone economy picking up more momentum, even as UK and US growth rates fell short of their forecasts.

In terms of its politics, Europe is looking more progressive. Austria, the Netherlands, and now France have all voted in pro-European leaders, rather than inward-looking populists. Next cab off the rank is Germany, which heads to the polls in September and where Angela Merkel – one of the EU’s biggest supporters – is a short odds favourite.

Unfortunately, the uplifting result in France could not have been in greater contrast to the almost farcical outcome of the UK elections in early June.

In mid-April, when Theresa May called for an early election to attempt to shore up her position at the Brexit negotiating table, the Conservatives held a 19 point lead in the polls. Only seven weeks later, they suffered the humiliation of having to form a minority government.

In what has been referred to as ‘the revenge of the remain voters’, the Conservatives embarrassingly saw their parliamentary seats fall from 331 to just 318; below the 326 needed for an absolute majority.

It was far from the unifying result Theresa May had hoped for. With inflation on the rise and Britain, for the first time since the mid-1990s, holding the mantle of the slowest- growing country in the European Union, the Conservatives headed into the Brexit negotiations with their tails between their legs.

In any summary of political events we, of course, cannot forget about Donald Trump. The US election may have been in November last year, but it seems the world is still struggling to come to grips with ‘The Donald’.

The best thing Trump supporters can find to say about the US president is that ‘he does what he says he will do’. That might have been perceived as a bigger virtue, except the things he says he will do are usually divisive, often strategically and ethically questionable, and nearly always controversial. Scrapping US involvement in the Trans Pacific Partnership trade deal and failing to ratify the Paris Accord on climate change are two examples.

While global investors might well be concerned about some of the policies emanating from the Oval Office promoting increased US separatism and greater racial inequality, that hasn’t translated into any reduced demand for US business output or debt securities.

In that sense, the market response is entirely rational. Regardless of the latest Trump tweet or seat-of-the-pants policy initiative, the demand for Big Macs, or iPhones or Cadillacs, hasn’t been affected, and is unlikely to be. Consumerism is inherently apolitical.

As if to reinforce this, the headline US S&P 500 Index registered a gain of 3.1% for the quarter and is now up 17.9% for the last 12 months, and 14.6% pa for the last five years. Other notable equity market results for the quarter were in Japan, where the Nikkei 225 gained 6.1%, and in France, where the CAC 40 Index gained 2.4%. In fact, it was a solid quarter for most developed share markets, with only five of the 23 developed markets tracked by MSCI indices returning negative results.

Emerging markets were, in typical fashion, more volatile. Thankfully, that volatility was more positive than negative this quarter, with the MSCI Emerging Markets Gross Index up 6.4% in US dollar terms. Some of the notable individual results contributing to this performance came from China +11.0% and Korea +12.8%. At the other end of the scale, the Russian sharemarket fell -6.0%, hurt by ongoing oil price weakness and by the Trump administration, against expectations, not repealing sanctions imposed in 2014 which punished Russia for its role in the Ukraine crisis.

The local New Zealand sharemarket delivered a strong result, with the S&P/NZX 50 Index (gross with imputation) gaining 5.9%. This was comfortably ahead of the result of our Australian neighbours, where the S&P/ASX 200 Index returned -1.6%.

New Zealand’s strong sharemarket performance may partly be a reflection that economic conditions here continue to look solid and business confidence remains strong. Positive business sentiment certainly bodes well for the future growth rates and profitability of New Zealand facing businesses. On the other hand, while overall Australian data also generally continues to beat expectations, the tailwinds supporting economic growth in Australia appear less consistent, as a spate of company earnings downgrades in June served to highlight.

In the midst of all of this, the New Zealand dollar strengthened over the quarter against both the US dollar (up 4.5%) and the Australian dollar (up 3.9%). A stronger NZ dollar has the effect of reducing the New Zealand dollar value of any unhedged assets denominated in either US or Australian dollars, and that contributed to slightly lower reported returns this quarter.

Global bond markets had been relatively uneventful for much of the quarter, although this changed rather sharply towards the end of June when European Central Bank President, Mario Draghi, announced that “the global recovery is firming and broadening and a key issue facing policymakers is ensuring that this promising growth becomes sustainable.”

These comments resonated strongly with the market, as they coincided with comments made by Bank of England Governor, Mark Carney, about the potential need to reverse the post Brexit rate cut in the UK, and comments from Bank of Canada Governor, Stephen Poloz, about the potential need to reverse the post oil price crash (2014/2015) rate cut in Canada. In addition, earlier in the month the US Federal Reserve had already signalled its determination to progressively remove stimulus in the US by lifting the Federal Funds rate from 1.00% to 1.25%.

What was less anticipated was the Federal Reserve retaining their future rate projections of one increase in 2017, followed by three hikes in 2018, and another three hikes in 2019.

This is almost the exact opposite of the approach being taken by our own Reserve Bank. In last month’s Monetary Policy Statement, the Reserve Bank looked through a string of firmer New Zealand inflation indicators and maintained their earlier projections that New Zealand rates will remain at record lows until 2019. It is apparent that the Reserve Bank believe raising rates too early – something they regretted in doing in 2014 – could undermine domestic growth.

Even though all bond markets felt some impact from Draghi’s comments and spiked upwards over the last week in June, it was not a sizable enough reaction to impact returns greatly. By the end of the quarter the Citigroup World Government Bond Index 1-5 Years (hedged to NZD) had gained 0.59%, while the slightly longer duration Bloomberg Barclays Global Aggregate Bond Index (hedged to NZD) advanced 1.22%. These were both satisfactory results, given the still compressed global yield curves.

All in all, while it was an extremely interesting quarter on the global stage, it was a relatively quiet quarter in the markets.

The ‘glass half empty’ view of this would be that we didn’t get another three months of the kind of excellent returns we have experienced with surprising regularity in recent years. The ‘glass half full’ view would be that diversified investors still came out ahead for the quarter, and we got a non-painful reminder that markets can’t be expected to only ever go up, and in large leaps.

For all long term investors, this was simply another positive step along the road towards the achievement of your ultimate investment goals and objectives.

And, by that most important of all measures, it was another successful quarter.

Note: Unless otherwise stated, all index returns are quoted on a home currency returns basis.